Treasury wants to limit tax planning

National Treasury wants to introduce a new section into the Income Tax Act which will put the brakes on some aggressive tax planning through trusts.

Trusts and their perceived use to transfer wealth without paying either donations tax or estate duty have for many years been a thorn in the South African Revenue Service's side.

The latest proposal aims at limiting tax avoidance by ways of interest free loans or loans with interest below market rates without being subject to either donations tax or estate duty.

Hanneke Farrand, tax director at law firm ENSafrica, says the proposed provision in the Draft Taxation Laws Amendment Bill would apply, for example, to a loan made to a trust by any individual who is a beneficiary of that trust or whose relative is a beneficiary of the trust.

It would also apply to a loan made to a trust by a company in which that individual holds more than 20 percent of the equity shares or voting rights.

Graham Crocker, tax associate at law firm Bowman Gilfillan, says the use of interest free loans to a local trust to enable the trust to fund assets, and then write-off the loan in annual R100 000 increments (the annual donations tax exemption amount) has been a common approach.

However, the new proposal aims to put a stop to that. Crocker says if one makes a loan to a normal family trust and the interest rate on the loan is less that the official rate (currently 8 percent), the lender will in future be subject to income tax on the deemed interest.

The deemed interest is the difference between the amount of interest actually charged and the official rate of interest.

In addition, the taxpayer who made the loan will not qualify for the normal tax exemption for interest (currently R23 800 for individuals under 65 years) on this deemed amount.

The taxpayer will also have to recover this tax liability from the trust within three years, or else it will be considered a donation, triggering donations tax on the amount.

Farrand adds, in terms of the proposed measure, the annual donations tax exemption of R100 000 will not apply to any amount that is used to pay off the loan, credit or advance allowance made to the trust.

She says the proposed amendments are expected to come into operation on March 1, 2017 and will apply in respect of years of assessment commencing on or after that date. "These proposals will, accordingly, apply to loans in existence at that date, which meet the requirements of the new provision, as well as to any subsequent loans," she warns.

Piet Nel, head of tax technical at the South African Institute of Tax Professionals (SAIT), says the draft is actually not totally clear on this aspect.

The relevant section uses the words "makes or provides any loan", but then in announcing the effective date, it does not clarify that it only applies to loans made on or after March 1, 2017.

Farrand says there has been uncertainty regarding changes to the tax treatment of trusts and estates since the Davis Tax Committee's first report on estate duty was released last year. These proposals give some clarification of the tax changes.

Dan Foster, tax director at Webber Wentzel, says the Davis Tax Committee's interim report on Estate Duty is still with the Minister of Finance for review, but the minister promised some changes this year already.

"It is important to note that the more punitive related measure proposed in the budget, namely that assets acquired by a trust with interest-free loan funding would be added back to the dutiable estate of the lender at his death, have not been proposed in the draft bill," says Foster.

Double tax?

Louis van Vuren, CEO of the Fiduciary Institute of South Africa, says if these more punitive measures were introduced on top of the proposed new section7C, it would have amounted to taxing the same amount twice.

The two measures were most probably always seen as alternative methods to obtain the same aim, namely to assist Treasury in preventing the use of interest free loans to transfer assets to trusts with no tax charge, Van Vuren says.

SAIT says one of their main concerns is that the proposal does not seem to recognize that other specific anti-avoidance may also apply to the same interest free loan.

Crocker says there are ways for taxpayers to minimize the punitive effects of the proposed new section, assuming it is introduced in its current form.

He says taxpayers can donate their annual R100,000 in cash, rather than donating by writing off loans that would not qualify for donations tax exemption.

"If you are not already using the annual interest exemption amount, charge interest at the official rate of interest (currently 8 percent) and claim this exemption (R23 800), rather than being taxed on deemed income that would not qualify for any exemption," he says in an article.

PwC says in its latest Tax Alert trusts remain an effective, flexible and valuable tool that can be used for a variety of purposes.

This includes not only estate planning, but also safeguarding wealth, affording protection against creditors and comprehensive family wealth planning.

Tax professionals point out that the proposals are still in draft form at this stage and the legislation has not yet been promulgated. Stakeholders have until 8 August to give their views on the proposed changes.

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